'Dr. Copper' gets tested

Year-to-date rally fuels hopes of a turnaround but track record is sullied

By

LauraMandaro

SAN FRANCISCO (MarketWatch) -- Should copper's Ph.D. status be rescinded?

A 9% rebound in copper prices this year recently unearthed the industrial metal's old nickname -- Dr. Copper -- a moniker it earned in past cycles for its ability to predict booms and busts. That's largely due to its widespread use in building and manufacturing.

Prices have shot up in the past few weeks after a surge of Chinese restocking and progress in passing a U.S. stimulus package prompted traders to bid up prices for the metal used in wiring and pipes.

But the base metal's forecasting qualities were tarnished in the past cycle. That's when copper prices, along with a broad range of commodities, stayed high even after the U.S. recession was well underway.

Driving prices higher last year, say some analysts, were pension funds and hedge funds that snapped up commodities as an alternative to stocks and bonds. Prices spiked for reasons other than physical demand; when they crashed, the sharp contraction in global credit was largely to blame. More than in past cycles, copper prices decoupled from industrial demand.

The ability for copper to predict the crash "was delayed. It was all money flow," said Bill O'Neill, managing partner at commodities brokerage Logic Investment Services.

The comeback in copper prices since Jan. 1 may again reflect the balance sheet management of financial investors, who are feeling less pressured to raise cash than they were at year-end.

"What we've seen in my view is less deleveraging selling," he said. "For some reason there's been a lot of optimism that there's going to a resurgence in base metals demand in anticipation of recovery. I think it's premature to expect that in the first half of this year."

Copper futures peaked at more than $4 a pound in July and then gave back all their gains in the final four months of last year, ending 54% lower at $1.41 a pound. But the U.S. recession started several months before that peak, in December 2007, according to the National Bureau of Economic Research.

"The spike in July was an aberration. It resulted from another wave of buying and a lot of fund activity," said Edward Meir, senior metals analyst at MF Global. "The funds can really exaggerate things. It has nothing to with underlying fundamentals," he said.

Recovery hopes

Indeed, prices have edged back this week as some optimism faded. But not before some analysts saw encouraging signs in the rise in copper since the start of the year. Its past correlation with industrial demand supported hopes that the economy had started to make small steps towards recovery and healthy inflation -- rather than sliding into a protracted, severe period of falling prices and shrinking output.

"I don't think it's likely we'll be in for a period of sustained deflation. It fact, inflation could be an irritant for policymakers by the end of next year," said Paul Kasriel, chief economist for The Northern Trust, in an interview earlier this week.

Among the signals suggestive of inflation, he said, were rallies in past weeks in gold, copper and the Baltic Dry Index, which measures dry bulk shipping rates.

Raymond James strategist Jeffrey Saut also noted earlier this week that "Dr. Copper" had rallied 11% in the past week alongside a broad gain in the Commodity Research Bureau index. "This action, if it continues, suggests the potential for the return of inflation and the potential for a stronger economy," he wrote.

China now accounts for about one-third of global copper demand, another reason its links with U.S. industrial output may be fading.

Copper has predicted inflation and industrial production peaks and troughs several times in recent history.

The turn in copper prices on a year-over-year basis led the turn in inflation by six to 12 months in 2000, 2001 and the first half of 2008, says Morgan Stanley.

In 2001, a drop in copper prices in the third quarter preceded a fourth-quarter plunge in industrial production.

In 1997, jump in copper prices in preceded a surge in industrial output six months later.

Copper prices had gained as much as 16% since the start of 2009, topping $1.63 a pound earlier this month from $1.41 at the end of last year.

That comeback has hit a wall in recent days, however.

The March contract has fallen back to about $1.53, for a 9% year-to-date gain, as skepticism about short-term Chinese demand growth and the U.S. stimulus package has softened expectations for a rebound in industrial appetite.

"There was a lot of optimism. It had to do with upcoming Senate and Congress actions on the stimulus package," said George Gero, a vice president in global futures for RBC Capital Markets.

"Now there's question of how quick you'll have a need for copper for infrastructure. You have ups and downs on almost a daily basis."

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